Fitch Affirms Indonesia's Inalum at 'BBB-'; Outlook Stable

(Fitch Ratings - Singapore/Jakarta - 03 May 2021)-- Fitch Ratings has affirmed PT Indonesia Asahan Aluminium (Persero)'s (Inalum) Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'BBB-' with a Stable Outlook. Fitch has also affirmed Inalum's senior unsecured rating and the rating on its outstanding senior unsecured notes at 'BBB-'.

Inalum's rating is one notch below the rating of Indonesia (BBB/Stable), in line with Fitch's Government-Related Entities (GRE) Rating Criteria. This is based on our assessment of strong linkages between Inalum and the state as well as the state's incentive to provide support.

We assess Inalum's Standalone Credit Profile (SCP) at 'b-' and expect standalone EBITDA/interest coverage, after adding net dividend and interest income to EBITDA, to remain below 1.5x and debt/EBITDA leverage, based on proportionate consolidation of key subsidiaries, at around 9x-10x in 2021-2022. Despite weak metrics, Inalum's SCP is supported by adequate liquidity due to robust banking relationships, especially with state-owned domestic banks. We estimate standalone coverage to improve to above 1.5x by 2023 once Inalum's economic stake in PT Freeport Indonesia (PT FI) increases, resulting in a substantial jump in dividend inflow.

KEY RATING DRIVERS

Strong State Linkage: Fitch regard Inalum's status, ownership and control by the Indonesian sovereign as 'Strong'. The company is fully government owned and is the state's mining holding company. The government transferred its stakes in three companies to Inalum - PT Bukit Asam Tbk (PTBA), PT Aneka Tambang Tbk (ANTAM) and PT Timah Tbk. Inalum now owns around 65% in each subsidiary. The government also mandated Inalum to acquire additional shares in PT FI, which operates the strategically important Grasberg mine.

We assess the sovereign's support record as 'Strong'. The government injected capital of IDR3.5 trillion into ANTAM in 2015 via a rights issue and consolidated mining assets under Inalum in 2017 to improve its business profile. There has been no direct government support since then, but Inalum and its key subsidiaries have benefited from robust access to state-owned banks to meet financing needs. We expect strong government support to continue.

State's Incentive to Provide Support: Fitch regards the socio-political implications of a default by Inalum as 'Moderate'. A default could damage the government's reputation and hamper Inalum's project funding, but is not likely to result in severe social-political fallout at the mining operations of Inalum's subsidiaries. We assess the financial implications of a default as 'Very strong'. Inalum is one of Indonesia's key state-owned enterprises and its default could damage investor confidence in the sovereign and other GREs.

Higher EBITDA in 2021: We expect consolidated EBITDA to jump by almost 40% in 2021 and for standalone EBITDA to increase by around 45%, driven by higher volume and prices for most products. Consolidated EBITDA fell by 9% in 2020 on weak demand and commodity prices, but the drop was mitigated by Inalum's success in cutting operating costs. However, EBITDA is likely to decline in 2022 and remain largely flat in 2023, as costs start to rebound and price realisations fall in 2022, based on Fitch's price assumptions.

Dividends from PT FI: We expect Inalum to receive close to USD200 million in dividends from PT FI in 2021, the operator of the large Grasberg copper and gold mine. We estimate dividends to rise to USD1 billion by 2024, driven by higher output and Inalum's greater economic interest in the asset from 2023.

Grasberg is transitioning to underground mining and PT FI expects metal sales to approach 90% of post ramp-up targets by mid-2021, up from 68% in 4Q20 on an annualised basis. Inalum's share of PT FI dividends will increase to 41.2% after 2022, from below 20.0%, taking into account a 10% stake transfer in PT FI by Inalum to the Papua government and Mimika Regency.

Trading Operation Neutral: Inalum started trading operations under a Singapore-based subsidiary in 2020. The trading arm has minimal debt and less than 10% of its purchases were from unrelated parties in 3Q20. Inalum expects the subsidiary to scale-up operations to manage the group's international marketing and sales efforts and trade diverse commodities. We do not think the ramp-up operation will affect Inalum's SCP at this level, with the company's diversified mining portfolio and weak interest coverage remaining the key drivers of its business and financial profiles, respectively.

Capex to Increase: We expect capex to increase in the next two to three years as the group proceeds with several projects aimed at increasing capacity and improving vertical integration. These include aluminium smelting capacity expansion, a new smelter-grade alumina refinery capable of processing its bauxite output, an increase in ferronickel processing and tin smelting capacity and the construction of coal-fired power generation capacity. Inalum may also undertake acquisitions to boost its share of domestic reserves of mineral resources.

DERIVATION SUMMARY

Our assessment of sovereign support can be compared with that for other GREs, such as PT Pertamina (Persero) (BBB/Stable), PT Hutama Karya (Persero) (HK, BBB-/Stable), PT Telekomunikasi Indonesia Tbk (Telkom, BBB/Stable) and China Minmetals Corporation (Minmetals, BBB+/Stable).

The ratings on Indonesia's national oil company, Pertamina, are equalised with the sovereign, reflecting a 'Very Strong' score on all GRE support parameters related to ownership and control, support record and expectations, socio-political as well as financial implications of default. Inalum scores lower on factors related to control, support and socio-political implications of default, as Pertamina receives regular subsidies for meeting the government's public-service obligations and state involvement in its investment decisions and budgetary support is exceptionally high. In addition, a default by Pertamina would hamper its ability to procure sufficient products, with a significant impact on the economy and general public.

Indonesian government-related construction company, HK, is rated at the same level as Inalum using a top-down approach, at one notch below the sovereign rating. We assess HK at 'Very Strong' for ownership and control as well as support record and expectations. The government, which fully owns HK, has close oversight of HK's boards of directors and commissioners and has provided equity injections, asset securitisation and construction assistance to support HK's order-book growth and toll-road investments in the last five years. The government also guarantees the bulk of HK's debt and we expect support to continue, with the company investing in Indonesia's longest toll road in Sumatra. However, we regard HK's financial implications of default as 'Strong', as we believe investors do not view the company as a proxy financing vehicle for the state.

The ratings of majority state-owned telecommunications company, Telkom, are constrained by the sovereign's rating. Similarly to Inalum, we assess Telkom at 'Strong' for ownership, control, support record and expectations and 'Moderate' for socio-political implications of default. We believe there would be a limited political and economic impact from any service disruption in network connectivity. However, we assess the financial implications of default at 'Strong', compared with 'Very Strong' for Inalum, as Telkom has lower outstanding debt and is not viewed as a proxy borrower of the state.

We assess Minmetals, which is fully owned by the Chinese government and receives support in the form of share capital and subsidies, as 'Strong' for ownership, control, support record and expectations. Similarly to Inalum, we regard Minmetals' socio-political implications of default as 'Moderate' due to the limited impact on the general public from potential disruption in domestic supply of base metals. However, we assess the financial implications of a default by Minmetals at 'Strong', because even though a default would make funding difficult for other central GREs, the impact would not be as significant as that of closer proxies to the central government, like key oil and power GREs.

Inalum's SCP is lower than that of mining-sector peers, such as Freeport-McMoRan Inc. (BB+/Positive), First Quantum Minerals Ltd. (B/Stable) and PT Golden Energy Mines Tbk (B+/Stable), due to Inalum's weak leverage and coverage metrics, despite a more diversified mining portfolio.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer

- Annual aluminium production of 247kt over 2021-2023 (2020: 245kt)

- Coal sales volume to increase to 34 million tonnes by 2023, from 26 million in 2020

- Nickel ore sales volume to increase to 7 million wet metric tonnes by 2023, from 3 million in 2020; ferronickel sales to increase to 29kt by 2023 (2020: 26kt)

- Average annual tin sales of around 50kt over 2021-2023 (2020: 56kt)

- Total capex of USD3.3 billion for Inalum and subsidiaries over 2021-2023, including contribution for Grasberg

- No acquisition-related outflow or inflow from divestitures.

RATING SENSITIVITIES

Developments that May, Individually or Collectively, Lead to Positive Rating Action

- Positive rating action on the sovereign, provided there is no significant weakening of the likelihood of the government extending support to Inalum.

- Strengthening of the likelihood of state support.

Developments that May, Individually or Collectively, Lead to Negative Rating Action

- Negative rating action on the sovereign.

- Weakening of the likelihood of state support.

For the sovereign rating of Indonesia, the following sensitivities were outlined by Fitch in its rating action commentary of 22 March 2021:

The main factors that could, individually or collectively, lead to positive rating action/upgrade are:

- External Finances: Reduction in external vulnerabilities, for instance, through a sustained increase in foreign-exchange reserves, reduced dependence on portfolio flows or lower exposure to commodity price volatility.

- Fiscal Finances: An improvement in the government revenue ratio in the next few years closer to the level of 'BBB' category peers, for example, from better tax compliance or a broader tax base, which would strengthen public finance flexibility.

- Structural: Continued improvement of structural indicators, such as governance standards, closer to those of 'BBB' category peers.

The main factors that could, individually or collectively, lead to negative rating action/downgrade:

- Fiscal Finances: A continued increase in the overall public debt burden over the next few years to levels well beyond our current forecasts, for example resulting from failure to reduce the fiscal deficit to pre-crisis levels or further accumulation of debt by publicly owned entities.

- Macroeconomic: A weakening of the policy framework that could undermine macroeconomic stability, for instance, resulting from continued monetary financing of the deficit in the next few years.

- External Finances: A sustained decline in foreign-exchange reserve buffers, resulting, for example, from outflows stemming from a deterioration in investor confidence or large foreign-exchange interventions.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Adequate Liquidity: Inalum reported readily available cash, including time deposits, of IDR28 trillion on a consolidated basis as of end-2020, compared with IDR16 trillion in short-term bank borrowings and current maturities of long-term debt. We expect the group's substantial cash balance to be sufficient to address its maturing debt in 2021, despite negative FCF. Thereafter, we expect Inalum to rely on refinancing to meet its repayment obligations, due to sustained large capex and negative FCF. Inalum's robust banking relationships should support its liquidity position and mitigate refinancing risk.

Our expectations are similar at the standalone level; we estimate that reported readily available cash, including time deposits, of USD1.2 billion will be sufficient to repay around USD500 million of bonds maturing in 2021, despite negative FCF. Inalum is likely to require refinancing to address debt maturities over the next two to three years, for which we expect the company to rely on bank financing and the bond market.

We believe Inalum's robust access to banks was unaffected by the restructuring of loans at PT Indonesia Chemical Alumina (ICA), a subsidiary of ANTAM, after ICA failed to repay the outstanding amount of USD34 million in 2020.

SUMMARY OF FINANCIAL ADJUSTMENTS

Material adjustments include the following:

- Unamortised borrowing costs have been added back to debt. Supplier financing liabilities have also been treated as debt.

- Customer advances have been included in working-capital liabilities, while accruals for bond interest expense and construction-in-progress have been excluded.

- Additional investment in PT FI and other associates and joint ventures has been treated as part of capex.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS

Inalum's IDR, senior unsecured rating and ratings on outstanding bonds are one notch below the rating of Indonesia.

ESG CONSIDERATIONS

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. (ends)